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US shareholder actions to enforce diversity policies

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This article was written by Miriam Kleiner.

Developments in diversity for Boards

In July 2020, a shareholder commenced an action against an American company for making false statements regarding the company's commitment to diversity. The case is still to be heard. Whilst a case based on diversity in this manner is highly unusual, it demonstrates the ever increasing focus on diversity on boards and in companies generally which should not be dismissed as a passing fad.

Background to the claim

In July 2020, a shareholder of an American company called Oracle filed a complaint in federal court alleging that the company made false statements in its proxy statements. The shareholder claimed that Oracle's directors "deceived stockholders and the market by repeatedly making false assertions about [Oracle's] commitment to diversity."  Oracle does not have any African-American directors or officers, and, because of this, the shareholder asserted that "the directors have breached their duty of candor and have also violated the federal proxy laws."

Interestingly, the shareholder also alleged that Oracle's auditor, Ernst & Young, had been ineffective because EY failed to report that Oracle's internal controls did not ensure non-discrimination and that the company is not "complying with its stated goals and initiatives regarding the promotion of diversity and the avoidance of discrimination and harassment."  The claim also stated, "Simply put, Oracle has no real commitment to diversity and its Board is turning a blind eye to the Company's miserable failure to ensure the 'diversity' trumpeted by the Directors in Oracle's filings with the [SEC] and its annual reports to shareholders." 

The case is yet to be decided but the shareholder has sought orders from the Court that three Oracle directors be replaced with minority directors, Oracle create a $700 million fund to promote diversity at Oracle, the external auditor be replaced, and the that Oracle be required to publish an annual diversity report. The shareholder has also requested that Oracle be required to set specific quotas for minority hiring over the next five years, with a revised executive compensation program tying 30% of executive compensation to achievement of diversity goals.

Diversity requirements in America, Canada and Australia

The basis of the above claim is not that Oracle breached any particular law regarding diversity targets or policies. Rather it is essentially a claim for misleading and deceptive conduct. Generally, matters relating to diversity quotas and the like are not legislated matters but are usually introduced by regulators. The exception to this appears to be California.

In 2018, California enacted legislation imposing gender quotas on corporate boards. Interestingly, the law is currently being challenged on the basis that it is unconstitutional. Whilst California remains the only U.S. state with mandatory minimum numbers of female directors, New York, Maryland and Illinois have enacted mandatory diversity disclosure requirements.

In July, a California lawmaker introduced legislation which would impose quotas for "directors from underrepresented communities," defined to include any individual who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian or Alaska Native, or who self-identifies as gay, lesbian, bisexual or transgender.

If signed into law, the bill will require every "publicly held" domestic or foreign corporation whose principal executive offices are located in California to have a minimum of one director from an underrepresented community on its board by no later than31 December 2021. No later than 31 December 2022, companies would be required to have two directors from an underrepresented community for corporations with more than four but fewer than nine directors and three directors from an underrepresented community for corporations with nine or more directors.

The Secretary of State would be required to publish on its website the number of corporations subject to the law that were in compliance during at least one point during the preceding calendar year. The bill would also authorize the Secretary of State to impose a fine of for noncompliance in an amount of $100,000 for a first violation and $300,000 for a second or subsequent violation.

The SEC has limited disclosure requirements regarding diversity. Public companies are required to describe "the specific experiences, qualifications, attributes or skills that led to the conclusion that a person should serve as a director" as well as how the board implements any diversity policies in the nominating process. A SEC Compliance and Disclosure Interpretation from 2019 states that if board members or nominees self-identify with specific diversity characteristics and consent to their inclusion in company disclosures, the company is expected to identify those characteristics and discuss how they were considered.

Canada has recently required diversity reports to be published each year as part of its "comply or explain" disclosure regime. Canadian companies are not required to have diversity quotas or targets. However, from January 2020, Canadian public companies are required to provide annual proxy disclosures regarding the diversity policies and practices pertaining to the board and executive leadership.

At a minimum, Canadian public companies are required to disclose information regarding four "designated groups," including women, Aboriginal persons, members of "visible minorities," and persons with disabilities. A Canadian company must disclose whether it has targets for representation for each designated group, any progress made toward achieving those targets, and the number and percentage of directors and executives from each of the designated groups.

A Canadian company must also disclose descriptions of any term limits and any written policies relating to the identification and nomination of directors from the four designated groups, as well as whether and how diversity is considered in the selection process for directors and senior management. A Canadian company may also disclose additional information about its directors and executives that the company believes contributes to its corporate diversity, such as age, sexual orientation, or other elements.

In Australia, listed entities are required to have and disclose a diversity policy under the ASX Corporate Governance Principles and Recommendations. Listed entities are also required to publish measurable gender diversity targets and how those targets are being met on an "if not why not" basis.

Legislating gender diversity targets, let alone general diversity targets, is unlikely to occur in Australia in the near future. However, entities may find themselves under increasing pressure from stakeholders to apply certain diversity targets as is occurring in America. In July, ISS sent a letter to certain American companies asking them to provide the race and ethnicity of each of their directors and named executive officers, to the extent that the company and the individuals are willing to report the information. It may be the case that this is around the corner for Australian companies.

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